Tuesday, September 29, 2015

Ludwig von Mises: Scholar of Free Markets and Prophet of Liberty

September 29 marks the 134th anniversary of the birth of Ludwig von Mises, the tallest giant of the “Austrian School” of economics. Although Mises is not a household name, Nobel laureate Friedrich Hayek once referred to him as “the master of us all.” To this day, professional economists and laypeople alike learn from the writings of a man I consider to be the most important economist of the twentieth century.

One of Mises’s earliest achievements was to bridge the two fields we now call microeconomics and macroeconomics.Originally, the classical economists of the eighteenth and nineteenth centuries had embraced variants of a labor theory of value in their teachings. Then, during the so-called Marginal Revolution of the 1870s, economists replaced the labor theory with the modern subjective theory of value, which sees all market prices as determined ultimately by the underlying preferences of consumers. It doesn’t matter how many labor-hours it takes to manufacture a product, according to subjectivism; if nobody really wants it, it will fetch a low price.

Economists gradually recognized the superiority of the new “subjective marginal utility” approach, but by the dawn of the twentieth century they still thought this worked only for “micro” explanations. The theory could explain, for example, how many bananas traded for how many apples, but economists still thought they needed an entirely different, “macro” framework to explain the money prices of goods.

Enter Ludwig von Mises. In his 1912 book, translated with the title The Theory of Money and Credit, he showed how to apply the theory of marginal utility to explain all market values -- even the value of money itself. In so doing, Mises put individual money prices, and the purchasing power of money, under the umbrella of a unified theory of value.

In the same book, Mises also unveiled what is nowadays called Austrian business cycle theory. Contrary even to some other free-market thinkers, he did not think that the typical boom-bust pattern in market economies was an intrinsic feature of capitalism. Instead, Mises argued that they originated in unsound banking practices, often instigated by a nation’s central bank. When banks expand credit in order to provide “cheap” loans, this artificially lowers interest rates to below their natural level, sending businesses and entrepreneurs a false signal that encourages unsustainable activity throughout the economy.

In particular, investment projects that are not justified by market fundamentals now appear profitable at the lower interest rates. The illusion created by the increased investment and spending can generate a period of apparent prosperity, but the economic boom rests on quicksand and eventually leads to a bust. According to Mises, rather than trying to restore the economy by engaging in deficit spending and monetary “stimulus,” the government should prevent the business cycle from getting started in the first place, by abstaining from central bank policies that make credit unnaturally cheap and induce the unsustainable boom.

In the 1930s, Mises’s theory was rapidly winning adherents among professional economists as the best explanation for the Great Depression. That is, until the charming John Maynard Keyes bamboozled almost everyone with the false promise that governments could deficit-spend the economy’s way back to health. To this day, most academics as well as the financial press adhere to the Keynesian notion that economic slumps are the result of consumer pessimism and inadequate spending.

But Mises’s most celebrated achievement by far was his critique of central economic planning. First in a 1920 academic paper and later in his 1922 treatise, Socialism: An Economic and Sociological Analysis, Mises explained that the central planners in a socialist commonwealth faced an insurmountable hurdle, one even more fundamental than the problem of poor incentives.

Because a socialist state owns all of the “means of production,” Mises noted, there could be no market prices for farmland, factories, barrels of crude oil, and all of the other inputs used in a modern economy. But in the absence of market prices, he explained, there could be no rational way for the government’s central planners to compare the costs of their economic plans with the benefits they hoped their plans would yield.

Even after their production strategies were implemented, they would see only a list of specific quantities of outputs (so many houses, diapers, restaurant meals, nylon stockings, etc.) to compare to a list of specific quantities of inputs (so many cords of wood, tons of steel, man-hours of engineering labor, etc.). Any comparison they could make, however, would be meaningless. Without the profit-and-loss test that market prices make possible, the central planners would have no way to determine whether or not their production plans made any economic sense.

Clearly, Ludwig von Mises was not only a giant of the Austrian school of economics. He was also one of the greatest social scientists in world history. In addition to his profound contributions in technical economics, including in monetary theory, business cycle research, and comparative institutional analysis, he was an unyielding advocate of individual liberty who understood like no one before him the ideas and practices necessary to secure the fruits of Western civilization. Mises asked the average citizen to learn the basic principles of economic science and remember them while voting at the ballot box. He knew that the blessings of economic freedom are available only in societies in which the government doesn’t sabotage the market.

Robert P. Murphy is a Research Fellow with Independent Institute and Research Assistant Professor with the Free Market Institute at Texas Tech University. His new book Choice: Cooperation, Enterprise, and Human Action crystallizes the key insights of Mises’s greatest treatise.